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Beyond Disclosure: The Case for Banning Contingent Commissions

In the last two years, insurers' payment of contingent commissions to insurance brokers and independent agents has come under wide-spread scrutiny from regulators, prosecutors and legislatures. Contingent commissions reward agents and brokers for directing large volumes of profitable business to insurance companies and may consequently create various conflicts of interests for these ostensibly independent intermediaries. The insurance industry, along with a chorus of sympathetic academics, has argued that these conflicts of interest can be adequately addressed by requiring that intermediaries disclose their receipt of contingent commissions to customers. Moreover, they have argued that contingent commissions may, in fact, improve the efficiency of insurance markets by reducing adverse selection. To date, these arguments have largely convinced lawmakers. This Article challenges that emerging consensus. It argues that, in consumer insurance markets, a mere disclosure requirement is an ineffective method for limiting the costs of contingent commissions or allowing consumers to meaningfully accept these costs through their market decisions. Contingent commissions are also unlikely to reduce adverse selection in consumer insurance markets, where empirical evidence has consistently shown that adverse selection is an exaggerated threat. For these reasons, the Article calls on state legislatures and regulators to ban contingent commissions in consumer insurance markets. The Article also raises the possibility that contingent commissions should be banned in insurance markets where purchasers of insurance are sophisticated commercial entities. It shows that an informed insurance purchaser might choose to purchase insurance through an intermediary that accepts contingent commissions even though the purchaser would prefer for these payments to be banned. It also demonstrates that contingent commissions may fail to appreciably reduce adverse selection by inducing high-risk, sophisticated insureds to engage in socially wasteful efforts to avoid actuarially fair classifications.